Principals and contractors will have to apply the new construction contracts retentions regime, due to come into force on 31 March, without the benefit of supporting regulation or a clear explanation of what they need to do.
The surprise decision not to produce timely regulations increases the uncertainty around the new regime’s implementation and broadens its impact (now no contract is too small).
Some last minute clarity may be provided regarding accounting records if the amendments to the Construction Contracts Act (CCA) delivered through the Regulatory Systems (Commercial Matters) Amendment Bill (Regulatory Systems Bill) are passed into law before 31 March, as anticipated.
But those same changes introduce choices which - while welcome - are poorly developed.
Shifting gaps in the system
Matters which were expected to have been set by regulation were:
- a threshold (de minimus) amount of retention money below which the new retentions regime would not apply
- prescribed methods of accounting for retention money, and
- the default interest rate for late payment of retention money (if none is agreed).
Ditching the first and second matters is surprising from a policy perspective, but the gap is manageable. The important point is that the retentions regime will now apply to all retentions withheld under all construction contracts entered into or renewed after 31 March 2017, no matter how small, unless the contract is for residential accommodation in which the principal resides or intends to reside. The absence of the third item is a problem. The Act is clear interest should be paid, but if the contract does not specify a default interest rate, it is not clear what rate applies.
The Regulatory Systems Bill goes some way to teasing out the second item, but states that the party withholding retentions (the payer) must make the accounting and other required records available for inspection by the intended payee (without charge). All potential payers must bear this in mind, having regards to commercial sensitivities.
But a new gap has opened up.
The key change in the Regulatory Systems Bill – the financial instrument option
As we have already advised, a late change to the Act delivered through the Regulatory Systems Bill, specifies that the retentions regime will not apply to construction contracts entered into before 31 March 2017.
More significantly, the Regulatory Systems Bill introduces flexibility, by providing a choice between holding retention money on trust or using a financial instrument which provides third party protection- in practical terms, a bond, guarantee or insurance policy – provided certain conditions are met:
- the instrument must be issued by a licensed insurer, registered bank, or person prescribed by regulations (Acceptable Issuers)
- it must be issued in favour of the payees
- the retention money must be paid out if the payer fails to make payment on the date due under the construction contract
- payees can enforce the promise to pay against the issuer of the financial instrument, and
- importantly, records of financial instruments must be made readily available to payees at no charge.
Those choosing this option will avoid the costs of maintaining a retentions trust account (or accounts) and of complying with the trust accounting requirements. However, many questions remain. Take five.
- Have enough Acceptable Issuers developed “ready to go", fit for purpose financial instruments?
- Will those financial instruments be widely available across the industry?
- Will they be materially cheaper than following the trust route?
- Will regulations be issued prescribing minimum or prohibited terms and conditions for financial instruments as the Regulatory Systems Bill envisages? And if so when?
- And what must a payer/payee prove in order to resist/extract payment?
On the last point, the obligation to pay can only be conditional on performance, but who must prove what to whom? As we see it, the retentions regime is primarily about isolating and securing the retention money, not necessarily about ensuring swifter release.
Complying with the retentions regime
If taking the trust route, consider contracting the specifics of the trust arrangement. This will help to manage expectations and to avoid the ambiguities still inherent in the retentions regime.
Ultimately it is beneficial for the payee to understand these terms before it prices the work. And clarity avoids disputes. It may also be beneficial (if not essential) to payers to develop a compliance plan internally and then roll this out in all their construction contracts. This would minimise the risk of non-compliance and manage the payers' administrative burden (by avoiding bespoke requirements for every payee).
Some examples of what may be agreed in a construction contract are:
- the default interest rate for late payment of retentions
- whether the money will be held in cash or “liquid assets"
- the accounting practices to be applied
- whether the retentions will be held in a separate account or commingled with other retention money in a 'project account', and
- the reporting requirements for the trust account.